Discussion Paper

Abstract

Much of the literature on the effect of housing wealth on consumption has been embedded in a simple life-cycle model in which housing price changes work as a "wealth effect". In such models, windfall gains in housing always lead to positive changes in consumption. However, this might constitute a fallacy of composition. Such models ignore that changes in housing wealth have distributional consequences between those planning to sell their house and those planning to buy a house. Further, since most housing is not simply financed out of current cash holdings but by mortgages, the institutions on mortgage markets have to be considered when looking at the "wealth effect" of housing. In this paper, a model is presented from which the classic Ando-Modigliani consumption function augmented by housing wealth can be deduced. It is shown that the deeper structural model from which this equation is deduced implies that changes in housing wealth are not necessarily positively correlated with consumption. It will be argued that changes both in demographics (the composition of the age groups in the population) as well as in mortgage markets have led to a structural break in the effect of housing wealth on consumption in the mid-1980s in the US. In the empirical part of the paper, two VAR models are estimated and impulse-response functions are computed. The results show that housing wealth changes did affect consumption differently before the mid-1980s and afterward. While both models show that consumption was positively related to housing wealth shocks after the mid-1980s, there was no or even a negative relation before.

Data Set

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Assessment

Comments and Questions

Jose Gomez
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Comments

April 07, 2014 - 17:18

Dear Professor Lindner,
I wanna say that it is a good work, but I didn't understand your comments about Trace Test at page 21 of two co-integrating relationships. I think that it is only one, but I may be wrong. And finally, you could use the Kalman Filter analysis to
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...study parameters evolution, what do you think about?
Best Regards, José.

Anonymous
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Comment

April 08, 2014 - 11:05

The paper makes an important contribution to the literature by explicitly investigating the ambiguous wealth effect of house price increases on non-house consumption both in an overlapping generations model as well as in an empirical investigation. Especially the prominent role of the demographic structure is an instructive result. If data
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...availability allows, further research might benefit from a wider-scale empirical investigation focusing not only on changes over time in US data, but also taking into account data from other countries with markedly different demographic structures and also different financial market structures. Since demographic structures vary significantly in international comparisons, this might be a non-trivial reason for differences in the wealth effect of housing price increases across countries.